Benefit Allocation Method – Definition

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Benefit Allocation Method Definition

The benefit allocation method refers to a way through which companies fund an employee pension plan. For each year, only one premium payment is made and it’s utilized to buy a single benefit. Usually, the plan states that for each unit of service, a specific amount would be received by the employee, either a stated salary percentage of a dollar amount, towards an employee pension.

A Little More on What is the Benefit Allocation Method

The details for the benefit allocation method of each company are likely included in the employee benefit plan of the company. The benefits are determined by the average of an employee’s salary in the long run. Employees who get highly compensated get more benefits solely because they have made more payments into the system. Typically, the transaction involves purchasing an annuity. Employees who are higher paid, having longer service usually get a greater benefit. For each year of service, payments are made to the employer.

Notable for companies is the fact that their method of benefit allocation should put into consideration that the costs associated with future years might align to increase continuously for specific segments of their employee population. For instance, individuals getting close to retirement age as they plan on leaving the company. Increases are as a result of the ever-shortening period within which interest is capable of compounding. Also, it can be magnified by the method of benefit allocation utilized by the company, and by the reduced possibility of terminating an employee before retirement.

On the other hand, for most plans, membership is open and there is a continuous joining of new members. Maintaining a balance is key. Provided the employee population’s average age is stabilized as new members join, and the younger ones balance the advancing ages of older employees getting closer to retirement, rates of contribution can remain consistent.

All things being equal, benefit allocation methods usually lead to lower funding levels as against equivalent cost allocation methods. There is a difference between cost allocation methods and benefit allocation methods because they check the total benefit costs, however, accrued, as an amount to have equal allocations to all service years. For instance, the aggregate level cost methodology usually takes the present benefit value minus asset value and then spreads the surplus amount over the future participants’ payroll. Aggregate cost methods, among others, consider the whole group and usually, the cost of the plan is calculated as a yearly payroll percentage. Also, the percent is adjusted each year in a situation where actuarial gains or losses exist.

References for Benefit Allocation Method

http://www.businessdictionary.com/definition/benefit-allocation-method.html

https://www.investopedia.com/terms/b/benefit-allocation-method.asp

http://www.businessdictionary.com/definition/benefit-allocation-method.html

https://financial-dictionary.thefreedictionary.com/Benefit+Allocation+Method

Academic Research on Benefit Allocation Method

  • Research on Methods for Allocation of Virtual Enterprise Benefit [J], Fei, Y. E. (2003).  Industrial Engineering and Management, 6, 44-47. Justified benefit allocation schemes is the key to VE success and its design is based on scientific methods of allocation. This papers studies VE benefit allocation methods and proposes a VE benefit allocation method based on asymmetric Nash negotiation model from the perspective of negotiation. It gives a VE benefit allocation method based on partner satisfaction level. A group weight model of VE benefit allocation is also established based on traditional group weight model. Three benefit allocation methods are analyzed with illustrative case study.
  • The Research for the Negotiation Model about the Benefit Allocation of the Dynamic Alliance [J], Dongchuan, S., & Fei, Y. (2001). The Research for the Negotiation Model about the Benefit Allocation of the Dynamic Alliance [J]. Science Research Management, 2, 011. The Dynamic Alliance will become the main organization of 21 st century. The partners take part in the Dynamic Alliance in order to attain more advantage. Therefore, that it the Dynamic Alliance can allocate the benefit reasonably will affect the achievement of the Virtual Enterprise. The Dynamic Alliance is a new teamwork model, so a few literatures have begun to research it .The paper think that the benefit allocation of Dynamic Alliance is a process of Group Decision Making (GDM), so this paper put forward the Nash Negotiation Model to allocate the Benefit of the Dynamic Alliance. In the end, this method is simulated.
  • The impact of taxes on corporate defined benefit plan asset allocation, Frank, M. M. (2002). The impact of taxes on corporate defined benefit plan asset allocation. Journal of Accounting Research, 40(4), 1163-1190. This paper investigates the extent to which taxes affect a corporation’s decision to allocate its defined benefit plan’s assets between equity and bonds. Prior theoretical research shows that if a corporation integrates its financial policy and pension investment policy, differences in tax rates create an arbitrage opportunity. The firm’s tax benefits from the arbitrage should be positively related to the percentage of its pension assets allocated to bonds. Consistent with this prediction, but contrary to prior empirical work, this paper finds firms’ tax benefits are positively and significantly associated with the percentage of their pension assets invested in bonds.
  • Pension funding, pension asset allocation, and corporate finance: Evidence from individual company data, Friedman, B. M. (1982). Pension funding, pension asset allocation, and corporate finance: Evidence from individual company data. This paper examines the relationship between U.S. corporations’ management of their pension plans and their management of the more familiar aspects of corporate financial structure. The chief conclusion, on the basis of data for 7,828 pension plans sponsored by 1,836 companies and their subsidiaries, is that corporations do not manage the pension plans which they sponsor as if these plans had nothing to do with the corporation. Different responses appear to characterize firms’ behavior in different contexts, but the evidence persistently indicates clear relationships between decisions about pension assets and liabilities and decisions about the other assets and liabilities of the firm. At the same time, the pattern of these relation- ships is, more often than not, inconsistent with familiar hypotheses that have emerged thus far in the theoretical literature analyzing pension aspects of corporate finance. Hence the conclusion from the data is also that the connections between pension decisions and corporate financial decisions in the more conventional sense are, at least as yet, not well understood.
  • The effect of pension accounting on corporate pension asset allocation, Amir, E., Guan, Y., & Oswald, D. (2010). The effect of pension accounting on corporate pension asset allocation. Review of accounting studies, 15(2), 345-366. We examine the impact of new pension disclosures and subsequent full pension recognition under FRS 17 and IAS 19 in the United Kingdom and SFAS 158 in the United States on pension asset allocation. These standards require recognition of net pension surplus/deficit on the balance sheet and actuarial gains/losses in other comprehensive income. Therefore, these standards introduce volatility into comprehensive income and balance sheets. We identify a disclosure period during which UK companies disclosed all the required data under FRS 17 in the notes without recognition. We also identify a full recognition period starting 1 year before until 1 year after the adoption of FRS 17/IAS 19 (UK) and SFAS 158 (US). We predict and find that UK companies, on average, shifted pension assets from equity to debt securities during both the disclosure and the full recognition periods. We also find that while before the adoption of SFAS 158 US companies maintained a stable allocation to equities and bonds, these companies, on average, shifted funds from equities to bonds around the adoption of SFAS 158. Cross-sectional analysis shows that the shift away from equities is related to changes in funding levels, shorter investment horizons, increased financial leverage, and the expected impact of the new standards on shareholders’ equity.
  • The impact of taxes on corporate defined benefit plan asset allocation, Frank, M. M. (2002). The impact of taxes on corporate defined benefit plan asset allocation. Journal of Accounting Research, 40(4), 1163-1190. This paper investigates the extent to which taxes affect a corporation’s decision to allocate its defined benefit plan’s assets between equity and bonds. Prior theoretical research shows that if a corporation integrates its financial policy and pension investment policy, differences in tax rates create an arbitrage opportunity. The firm’s tax benefits from the arbitrage should be positively related to the percentage of its pension assets allocated to bonds. Consistent with this prediction, but contrary to prior empirical work, this paper finds firms’ tax benefits are positively and significantly associated with the percentage of their pension assets invested in bonds.
  • Optimal funding and asset allocation rules for defined-benefit pension plans, Harrison, J. M., & Sharpe, W. (1982). Optimal funding and asset allocation rules for defined-benefit pension plans. This paper considers a world in which pension funds may default, the cost of the associated risk of default is not borne fully by the sponsoring corporation, and there are differential tax effects. The focus is on ways in which the wealth of the shareholders of a corporation sponsoring a pension plan might be increased if the Internal Revenue Service (IRS) and the Pension Benefit Guaranty Corporation (PBGC) follow simple and naive policies. Under the conditions examined, the optimal policy for pension plan funding and asset allocation is shown to be extremal in a certain sense. This suggests that the IRS and the PBGC may wish to use more complex regulatory procedures than those considered in the paper.
  • An empirical analysis of the factors underlying the decision to remove excess assets from overfunded pension plans, Mittelstaedt, H. F. (1989). An empirical analysis of the factors underlying the decision to remove excess assets from overfunded pension plans. Journal of Accounting and Economics, 11(4), 399-418. This study empirically examines possible motivational factors leading to reductions in pension plan overfunding. The results indicate that firms with severe financial weakening terminate pension plans. Firms with less severe financial weakening change actuarial assumptions to reduce required cash contributions to pension plans. Although decline in marginal tax rates and increased susceptibility to takeover are positively associated with overfunding reductions, increased financial weakening appears to be the most plausible explanation. The results are consistent with termination of pension plans being a costly source of financing.
  • The effect of pension accounting on corporate pension asset allocation, Amir, E., Guan, Y., & Oswald, D. (2010). The effect of pension accounting on corporate pension asset allocation. Review of accounting studies, 15(2), 345-366. We examine the impact of new pension disclosures and subsequent full pension recognition under FRS 17 and IAS 19 in the United Kingdom and SFAS 158 in the United States on pension asset allocation. These standards require recognition of net pension surplus/deficit on the balance sheet and actuarial gains/losses in other comprehensive income. Therefore, these standards introduce volatility into comprehensive income and balance sheets. We identify a disclosure period during which UK companies disclosed all the required data under FRS 17 in the notes without recognition. We also identify a full recognition period starting 1 year before until 1 year after the adoption of FRS 17/IAS 19 (UK) and SFAS 158 (US). We predict and find that UK companies, on average, shifted pension assets from equity to debt securities during both the disclosure and the full recognition periods. We also find that while before the adoption of SFAS 158 US companies maintained a stable allocation to equities and bonds, these companies, on average, shifted funds from equities to bonds around the adoption of SFAS 158. Cross-sectional analysis shows that the shift away from equities is related to changes in funding levels, shorter investment horizons, increased financial leverage, and the expected impact of the new standards on shareholders’ equity.
  • An empirical analysis of the factors underlying the decision to remove excess assets from overfunded pension plans, Mittelstaedt, H. F. (1989). An empirical analysis of the factors underlying the decision to remove excess assets from overfunded pension plans. Journal of Accounting and Economics, 11(4), 399-418. This study empirically examines possible motivational factors leading to reductions in pension plan overfunding. The results indicate that firms with severe financial weakening terminate pension plans. Firms with less severe financial weakening change actuarial assumptions to reduce required cash contributions to pension plans. Although decline in marginal tax rates and increased susceptibility to takeover are positively associated with overfunding reductions, increased financial weakening appears to be the most plausible explanation. The results are consistent with termination of pension plans being a costly source of financing.

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